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So the European Union is at it again. There is a lot to keep up with these days what
with all of the BEPS proposals and the November release of the promised Multilateral
Treaty Instrument by the Organization for Economic Cooperation and Development, varying
progress on implementation steps for Base Erosion and Profit Shifting taking place
at the country level, and the increased prospect of U.S. tax reform after the election
of Donald Trump. But obviously the E.U. doesn't want to be forgotten either, so it
has been active in proposing Directives inspired by the BEPS agenda — although not
always completely in line with the OECD's BEPS recommendations. So far the E.U. has
produced two versions of so-called Anti-Tax Avoidance Directives, a proposal for public
disclosure of country-by-country reporting data and some nasty State Aid decisions
likely with more to come. In November it added a re-proposal of Directives on the
Common Corporate Tax Base (“CCTB”) and the Consolidated Common Corporate Tax Base
(“CCCTB”), which was last proposed in 2011 as a single proposition. These are now
being proposed in two phases — first the double C, which would establish a common
approach to the computation of taxable income across the E.U.; and a second phase,
the triple C, which would require consolidated filing in the E.U .and apportionment
of income among all E.U. member states.

I critically commented on the original 2011 proposal as overly ambitious, impractical
and less than fully thought through. Obviously, I was not the only critic;
a number of E.U. countries were opposed and indeed the current re-proposal states
that the original “CCCTB proposal, being a very ambitious project, would be unlikely
to get adopted in its entirety….”
So the conclusion of the E.U. was not to abandon the plan but instead to repackage
it in the two parts described above. The expectation was that countries should be
committed to both elements and thus that the full CCCTB should still be adopted across
the E.U. in the “near”
term. (And by the way, the new proposal would be mandatory —
not optional.) It seems like I am not alone in thinking that a consolidated apportionment
system is not a good idea for driving investment growth in the European Union. But
it also seems like European Commission authorities with entrenched views are not listening.
Perhaps the thinking was that with the E.U. exit of the United Kingdom, which had
been critical of the original proposal, this was another opportunity to push it through.

I'll focus this commentary on the CCTB, and not on the triple C proposal on consolidation.
While consolidation raises the most concern, I feel there is enough not to like about
a mandated common tax base and hope that countries and commentators are vocal about
that and do not wait until “round 2” to start expressing their concerns.

First of all, let me point out that as a directive, the adoption of the CCTB requires
unanimous consent by all 28 countries that currently are members of the European Union.
It is possible to adopt tax principles by way of “enhanced cooperation,” which could
be done on a majority basis, but the principles would then apply only in countries
that agree to it. In the case of the CCTB or CCCTB, it seems clear that the enhanced
cooperation route will not be and is not appropriate to pursue, so adoption of the
plan would be all or nothing. I'll point out some double C areas where I feel countries
should object. But, historically, some larger E.U. countries — notably Germany, France
and Italy — have been supportive of CCCTB. If they are on board, a veto by a smaller
country is likely politically difficult. And while the United Kingdom will be at the
table for the next few years as it negotiates its “Brexit,”
it cannot realistically exercise a veto. On the whole the United Kingdom may not be
bothered by some impractical E.U. rules if it will no longer be a part of that club
going forward. In fact, the United Kingdom has been promoting itself as open for business
and a good investment destination. I believe the way they implemented the Diverted
Profits Tax and are proposing to implement the hybrid mismatch rules is very investor-unfriendly
and go well beyond an arm's-length standard. But there are potential aspects of the
CCTB which have similar features. If I were the United Kingdom and eager to attract
business post-Brexit, I might be pleased to see a complex and potentially overreaching
E.U. system implemented. Overall, I do think that the CCTB contains a lot to be concerned
about. I'll give some examples in this commentary.

So what is the CCTB all about? The goal is to implement a common corporate tax base
(but not a common tax rate) across all 28 E.U. countries. The Proposed Directive to
accomplish this is 53 pages including explanations. For a U.S. tax guy used to the
complexity of the Internal Revenue Code and Regulations, boiling down all aspects
of a corporate tax system to 53 pages seems impossible. By definition, there must
be lots of details which need to be left to the countries to implement or which must
be further articulated by the E.U. technical staffs which could either create lots
of inconsistences (which means not such a “common”
corporate tax base) or be potentially scary if left to the European Commission to
figure out.

Let's go through some of the details of the proposals to see how scared we should
get.

First of all, the proposal for the CCTB would apply to all corporate groups that
file consolidated accounts which have revenue of over 750 million pounds. That threshold
is for worldwide groups and not just E.U. headquartered groups. Thus, U.S. multinationals
and non-U.S., non-E.U. multinationals with that level of turnover would be covered
regardless of the size of their E.U. subsidiaries or branches. The threshold is similar
to the threshold for country-by-country reporting under Action 13 of the OECD initiative,
but not exactly the same. The exception for smaller groups or non-consolidated groups
would mean that an E.U. country would not be required to conform its local tax rules
to the common corporate base for those excluded companies in its country. I am not
sure how practical it will be to maintain two corporate tax systems and then to put
the burden on the countries to figure out whether a local subsidiary is eligible to
the non-CCTB rules.

In defining the scope of the proposed CCTB, it is best to start with revenues. Generally
all revenue is to be included in the common tax base. The significant exclusion is
with respect to dividends or gain or loss from 10%-or-greater owned subsidiaries.
The participation exemption is 100%, as opposed to the 95% exemption in the 2011 proposal.
However, the reduction to 95% in 2011 was stated to be a proxy from the disallowance
of costs relating to exempt income. The current proposal on its face seems more generous
but in regard to expenses specifically would disallow expenses related to exempt income
— including participation exemption income — but provides no guidance on how to do
so. Presumably, each country could devise (or maintain if they have a current rule
in their law) an expense apportionment approach. Again, doesn't sound too “common”
a base to me.

The definition of exempt participation income would also be subject to a so-called
“switchover” clause. The switchover clause would deny exemption to dividends or capital
gain for subsidiaries which are subject to local tax of less than one-half of the
rate in the parent/recipient country. In such case, foreign tax credits, rather than
income exemptions, would apply. Interestingly, the switchover clause was proposed
by the E.U. in the first Anti-Tax Avoidance Directive
(“ATAD”) but was excluded from the final ATAD presumably as a result of negotiations
and based on objections by the member states. The inclusion in the CCTB proposals
is merely three short paragraphs long, seems to just ignore the prior objections and,
needless to say, would require the E.U. member states to adopt some very complex foreign
tax credit provisions (similar to what we're used to in the United States) to implement.
Another example of the E.U. drafters just not listening?

As for deductions allowed in computing the CCTB, business costs would generally be
deductible with some interesting points below:

Interest costs would be deductible but with limits on net interest costs set at 30%
of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) consistent
with the ATAD and with Action 4 of the OECD BEPS proposals. There is an exception
for interest incurred with respect to infrastructure and a grandfathering of pre-effective
date loans.

Rules are provided for depreciation and amortization of fixed assets. Specific useful
lives are provided for certain assets subject to straight line depreciation. For intangible
assets, only intangibles that are eligible of being valued independently are included
in depreciable fixed assets. Therefore, it would seem that overall goodwill of a business
is excluded and would not be amortizable. This seems like a big deal as many countries
in the E.U. do allow currently for goodwill amortization. Should they object?

Four seemingly favorable provisions are included:

A tax-free rollover provision would be allowed when gain is realized on a fixed asset
and a replacement asset is acquired before the end of the second year after the tax
year of disposal.

A special deduction would be provided, in the nature of an allowance for growth and
investment. This would operate similar to a notional interest deduction. An increase
in a company's equity for a year would produce a notional deduction for the next 10
years equal to the equity increase times an interest rate equal to the 10-year government
bond rate in the Euro area (gratefully with a floor of zero at any time when Euro
rates are negative). Note that this allowance could be positive or negative. If a
company's equity were decreased, the “notional interest” would result in an increase
in taxable income.

A special super-deduction would be allowed for research and development expenses.
Taxpayers would be allowed an extra deduction equal to 50%
of their R&D costs for the year (25% to the extent the R&D costs exceed $20 million).
However, there is no mention in the proposed directives of patent-box-tax-type regimes
which are increasingly common around Europe. It seems to me that the special R&D deduction
is meant to be in lieu of a special patent box/intellectual property
(IP) box tax rate. If so, that is a big deal and will raise objections.

There would be an allowance for the deduction of cross-border losses of subsidiaries
or branches — “to make up for temporarily depriving taxpayers from the benefits of
consolidation,” at which time all profits and losses of a group would be naturally
consolidated. However, the deduction of such losses will be subject to recapture in
the deducting company when profits are realized by the subsidiary or, in any event,
no later than five years after the loss was deducted. At today's low interest rates
this seems of minimal benefit but would add lots of complexity.

The CCTB proposal does include the various anti-avoidance provisions included in the
E.U. ATAD proposals.

As indicated above, the interest limitation rules of OECD Action 4 are included with
a bit of amendment.

There is a provision for exit taxation.

There is a general anti-avoidance regime (“GAAR”) and there are mandatory CFC provisions
which are focused on passive income and re-invoicing activities.

Hybrid mismatch rules are included also encompassing imported mismatch similar to
the OECD Action 2. Interestingly the OECD Action 2 recommendations ran about 300 pages. The hybrid mismatch
legislation in the U.K. ran over 50 pages (so some stuff is left to the imagination).
A separate E.U. directive on hybrids (also issued in November 2016) runs for 19 pages,
whereas Article 61 of the CCTB on hybrids runs slightly more than one page. This is
further evidence that the countries will likely need to fill in the gaps and MNCs
will be left with lots of uncertainty and lots of potentially aggressive local interpretation
that could lead to double taxation.

So overall, it doesn't seem to me that a very common corporate tax base is anywhere
near assured based on the high-level definitions and concepts provided. All the E.U.
countries have working corporate systems of their own which are based on their overall
policy objectives as well as how they have decided to set their tax rate. I admit
that, as a U.S. practitioner, I am used to detailed rules. Maybe the idea here is
more along the lines of a principles-based approach with high-level minimum standards
for dealing with difficult or potentially tax-abusive areas. But it doesn't seem like
that's the idea. The explanatory introduction to the proposed directive in relation
to the anti-avoidance elements of the ATAD states that “the norms would need to be
part of a common E.U. wide corporate tax system and lay down absolute rules, rather
than minimum standards.” So these vague provisions with lots of open questions seem
to be the E.U.’s idea of absolute rules. And if the high-level open questions are
meant to be interpreted consistent with certain principles, I'm worried about the
principles that various E.U. tax authorities who seem to be revenue focused and seem
to have developed an entrenched view of many multinationals as unscrupulous tax avoiders
have in mind. So in my view, this is not a very favorable proposal for companies.
And I see little upside for E.U. countries to go through the complex, sovereignty
ceding process of adopting the vague but complex system in anticipation of an even
more complex consolidation and apportionment system, which will certainly produce
distinct winners and losers among the E.U. member states.

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